When taking a position on Canadian banks, Rory Ronan assesses financials’ financials. “Earnings for the banks well exceeded [my] and the market’s expectations,” he says, referring to fiscal third-quarter earnings, which he views as sound.
“The banks’ earnings were driven by better credit and continued solid expense control driving positive operating leverage,” he explains. “On a segmented basis, core banking — personal and commercial — and wealth management reported low double-digit earnings growth, offset only by a decline in capital market earnings.”
In the weeks since Canada’s big banks reported – that occurred in late August – their shares have “responded positively,” says Ronan, a portfolio manager at CIBC Asset Management, and manager of the Renaissance Canadian Dividend Fund. As of October 11, all of the Big Five have seen their stock prices rise since late August.
“One name that I was particularly impressed with was TD Bank,” he adds. “It’s a company that has a very strong retail presence in both Canada and the United States, and, after the earnings report, I increased my position slightly in [the bank], as it has lagged relatively year-to-date.”
Why to watch rising rates
Rising interest rates can benefit banks in that they’ll have higher net interest margins, says Ronan. Hikes can also boost insurance companies, he notes, since “their liabilities are fixed but, as interest rates rise, they receive a higher income from their assets.”
So it may seem that as monetary policy tightens, favouring financials seems like a no-fail move. However, risks like rising household debt and a too-hot housing market could cause some investors to steer clear.
Also, says Ronan, rate hikes can have a negative side: “The market may start to compress earnings multiples,” he says.
Despite there being two hikes in 2017 already, Ronan expects the Bank of Canada’s further tightening to be gradual. That’s because the BoC has so far surprised the market.
“As a result, Canadian currency has risen quite sharply […],” he says – in May, the loonie was sitting around US$0.73 and it’s now hovering around US$0.80. Says Ronan: “While in the medium to long term, interest rates should normalize, the fact that the currency has risen so sharply in such a short period of time means the Bank of Canada will likely pause interest rates for the time being.”